A good way to diversify an investment portfolio is to look beyond the domestic market and acquire foreign stocks. International investing offers the benefits of diversification such as increased return potential and hedges again domestic macroeconomic woes. Because every sovereign country has its own government policy and its own economy, adding these stocks will not necessarily increase the overall portfolio's risk due to low correlations between various countries' markets with each other and with the domestic market. (For more, see: Getting Into International Investing.)
Buying directly from foreign exchanges might seem like the most straightforward way to invest in foreign stock markets; however, this can be much more difficult than it sounds. Many U.S. Brokerage firms do not have direct access to international trading and if they do, it can be quite expensive and take quite a long time to receive a trade confirmation. You can contact your broker to ask if they offer direct international trading and how much it might cost. Even so, many countries impose capital controls to restrict the amount that a foreigner can invest and may tax transactions very differently than at home. U.S. taxation issues such as duties on foreign transaction costs may come in to play as well. (For more, see: I live in the U.S. How can I trade stocks in China and India?)
Holding foreign assets denominated in their respective currencies also exposes an investor to currency risk because foreign exchange markets fluctuate day to day. If an investor were to gain 5% in a foreign stock but lose 10% in the currency value, they would realize a net loss.
Think Internationally Act Locally
There are easier and more efficient ways to buy international stocks while avoiding some of the issues described above.
ADRs (American Depository Receipts) are shares of foreign stocks that trade on U.S. stock exchanges and can be bought and sold like any other stock through a domestic brokerage firm. ADRs are certificates issued by U.S. banks representing a certain number of shares of a foreign stock. They are denominated in dollars, and any cash flows from the company such as dividend payments will pass through to the ADR holder in dollars. Tax treatment for these investments are typically the same for any other stock investments, however some countries withhold taxes on dividends while the IRS requires a tax due on such dividends. Often times the amount of the foreign tax can be claimed by the investor as a tax deduction.
Some examples of popular ADRs that trade actively in the U.S. include American Movil (AMX), Teva Pharmaceuticals (TEVA), UBS AG (UBS), Petrobras (PBR), Baidu Inc. (BIDU), Ali Baba (BABA), Vodafone (VOD) and Sodastream (SODA).
While ADRs allow for the purchase of individual foreign stocks easily and efficiently on U.S. markets, they still carry currency and foreign inflation risk as well as the overall credit risk of the economy the country operates in.
ETFs and Mutual Funds
Some examples of ETFs that give an investor exposure to stocks in specific countries include:
There are also ETFs and mutual funds that invest in multinational portfolios so that an investor can gain exposure to specific regions or multiple parts of world markets without having to select a single country:
|Developed Markets Excluding U.S. and Canada||EFA|
|All World Excluding U.S.||VEU|
Mutual funds and ETFs can also allow investors to speculate on or hedge currency risk:
For more, see: Profit From Forex With Currency ETFs.
The Bottom Line
Diversifying an investment portfolio to include international assets can be beneficial. Investing directly in foreign stocks, however, can often be tricky and inefficient. There are easier ways to gain access to international markets through ADRs, mutual funds, or ETFs. Each foreign company and country possesses its own specific risks that need to be considered, both political and economic.